The dot plot shows what individual Fed policy makers currently think will be the appropriate level of the federal funds rate at the end of 2016, 2017 and 2018 — and in the longer run.

While European intelligence agencies are trying to connect the dots between recent terrorist attacks in Paris and Brussels, economists in the U.S. are struggling to disentangle a different set of dots: those that offer insight on economic, not national, security.

Specifically, a plot of dots, familiarly known as the “dot plot,” has come under attack recently from some academics, including Narayana Kocherlakota, who until last year was president of the Federal Reserve Bank of Minneapolis. In a curious piece last week for Bloomberg View, Kocherlakota voiced his concerns about the dot plot, a pictorial representation of the expected path of the federal funds rate from each member of the Federal Open Market Committee.

He wrote the following:

“The dot plot has two big perception problems. The first is the belief that it reflects officials’ interest-rate forecasts. It doesn’t. Rather, it shows what each participant thinks the Fed should do, based on his or her individual forecast of how the economy will evolve and what the optimal response would be.”

Confused? Me too — by Kocherlakota.

Let me see if I can explain. Each FOMC member gets one dot. The dot reflects his or her interest-rate forecast based on his or her economic outlook. That outlook — for real GDP growth, inflation and the unemployment rate — is also provided in a table showing the range of forecasts. Combining the forecasts yields a median forecast. Eliminating the three highest and lowest projections provides what’s known as the central tendency of FOMC members.

The second problem with the dot plot, according to Kocherlakota, is that “investors tend to see the dot plot as a commitment about the trajectory of rates.”

They do? The fed funds futures market — investors placing wagers on future Fed actions — has consistently displayed its rebellious streak, defying the Fed’s “commitment” at every turn. It wasn’t until shortly before the December meeting that the probability of a rate hike first exceeded 60%, which is the minimum threshold for Fed action dating back to 1994, according to Jim Bianco, president of Bianco Research.

If anything, the Fed’s commitment has proven to be flexible, deferring to market, or investor, expectations.

I’ve been critical of the Fed for its obsession with forward guidance, for hiding behind words rather than using them to clarify what it clearly doesn’t know. Fed Vice Chairman Stanley Fischer, prior to joining the Fed, was a proponent of less-is-more forward guidance, at least in certain circumstances. Speaking at a conference in Hong Kong in September 2013, Fischer said “You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know.”

In a report prepared for a monetary policy forum at The University of Chicago Booth School of Business last month, five academic and Wall Street economists advocated scrapping “time-based guidance” in favor of a “data-based reaction function,” laying out how the Fed would adjust interest rates based on certain information.

The Fed relied on just such a data-based reaction function starting in December 2012, pledging to keep interest rates “exceptionally low… at least as long as the unemployment rate remains above 6.5%” and inflation and inflation expectations met prescribed measures.

So what happened? The data intervened to spoil the party. In March 2014, with the unemployment rate approaching 6.5%, the Fed was forced to “update” its forward guidance.

And there’s the rub. The Fed may have planned to proceed with four rate hikes this year based on projections that unemployment and inflation would reach mandate-determined levels, but global financial market volatility and a dive in the S&P 500 Index
SPX, +0.14%
at home upended policy makers’ best laid plans.

As Fischer noted in his 2013 speech: “If you give too much forward guidance you do take away flexibility.”

Thresholds come and go. External events intervene. High-yield debt markets show signs of distress. China slashes its demand for raw materials. Lower oil prices turn out to be a drag, not an accelerator. The productivity slowdown proves to be a structural, not a cyclical, phenomenon. Or, as Fed Chairwoman Janet Yellen said in a speech on Tuesday, “global developments pose ongoing risks.”

There is always something to give a central banker pause, which is why forward guidance of any kind is such a dicey proposition. But chastising the Fed for releasing a set of dots? C’mon.

The Fed introduced the dot plot in January 2012 in an effort to convey more information to the public. It was another step in the ongoing effort, starting in 1994, to increase transparency. The constant downward revisions to forecasts for economic growth and the path of the funds rate prove that the Fed’s econometric models are human.

It all sounds jejune to me. I wish Fischer would assert himself when it comes to the inherent problems with forward guidance.

And as for Kocherlakota’s complaint that investors have no way of knowing which dot equates with which policy maker, there is a simple solution. Just initial the dots or superimpose a photo. Isn’t that what transparency is all about?

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